A class action lawsuit has been filed against three financial corporations, including banking giant Wachovia, alleging Illinois homebuyers were forced into negative amortization after the banks deceived them when they issued option adjustable rate mortgages.

Lead class plaintiffs Michael and Jayme Brunkhorst claim the lenders and brokers that sold them an option ARM mortgage on Aug. 18, 2005, touted the minimum payment and downplayed or failed to disclose the negative amortization that could result from making such payments, according to the suit filed Feb. 17 in U.S. District Court.

In option ARM mortgages, borrowers can choose to make mortgage payments one of four ways – to make a minimum payment amount, an interest-only payment, a payment based on a 30-year amortization or a payment based on a 15-year amortization.

The Brunkhorsts chose to pay the minimum monthly payment, believing it would pay both principal and interest due on the loan.

Up to 80 percent of borrowers, like the Brunkhorsts, make only the minimum payment each month, the suit claims. However, the minimum payment does not pay off any of the principal balance and only pays a portion of the interest that accrues on a monthly basis.

The unpaid interest is added to the balance of the mortgage, resulting in negative amortization.

Once that negative balance reaches 125 percent of the original loan, the mortgage is reset and the homeowners are forced to pay a much higher monthly payment than what they had been previously making.

As a result, borrowers are also forced to pay a greater interest rate on the original principal than what was originally set forth in the loan, according to the complaint.

"Option ARM loans have been called 'the riskiest and most complicated home loan product ever created' and have been termed a 'neutron bomb' that will kill all the people but leave the houses standing' by an economist at the Ford Foundation," the suit states.

However, when the Brunkhorsts entered into the pick-a-payment loans, they were not informed of the various risks, including negative amortization and the fact that the minimum payment did not represent the full cost of the loan, they claim.

"Defendants, through the standardized loan contracts they created and supplied to Plaintiffs, stated that negative amortization was only a mere possibility," the suit states. "Defendants also failed to inform the Plaintiffs and the Class Members that when the principal balance increased to a certain level they could no longer select the minimum payment option."

Lenders frequently try to push the ARM loans on borrowers because the loans are profitable to companies, the Brunkhorsts claim.

"Under generally accepted accounting principles the entire interest payment due could be booked as income even when only the minimum payment was made," the suit states. "This accounting practice enabled lendors to use Option ARM loans as a means to generate phantom profits, thereby boosting their stock price."

Because the Brunkhorsts and other class plaintiffs decided to use the Option ARM loans, they are forced to incur additional interest charges that have resulted from negative amortization, they claim.

In addition, they faced an increased chance of losing their homes through foreclosure and have limited ability to make future house payments or obtain alternative home loan financing, according to the complaint.

The Brunkhorsts and the putative class are seeking unspecified declaratory relief, compensatory damages, rescission, restitutionary disgorgement of all profits the banks obtained, plus costs, interest, attorneys' fees and other relief the court deems just.

They are also asking the court grant equitable relief to restructure their loans through rate buy downs, principal reduction and conversion into conventional fixed rate loans.

They are represented by Evan D. Buxner of The Buxner Law Firm in St. Louis. Daniel O. Myers, A Hoyt Rowell, III, Robert S. Wood and Catherine H. McElveen of Richardson Patrick, Westbrook and Brickman in Mt. Pleasant, S.C., will serve of counsel.

U.S. District Court case number: 09-129-GPM

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